Are the Bank of Korea's Inflation Forecasts Biased Toward the Target?

TL;DR

This paper investigates whether the Bank of Korea's inflation forecasts are biased towards its target and finds evidence of bias, while also evaluating bias correction methods that improve forecast accuracy.

Contribution

It extends bias testing to a state-dependent framework and assesses various bias correction strategies, highlighting the effectiveness of AR(1)-based adjustments.

Findings

BoK's inflation forecasts are biased towards the target in a state-dependent manner.

Bias correction strategies generally improve forecast accuracy.

AR(1)-based correction provides stable and consistent error reduction.

Abstract

The Bank of Korea (BoK) regularly publishes the Economic Outlook, offering forecasts for key macroeconomic variables such as GDP growth, inflation, and unemployment rates. This study examines whether the BoK's inflation forecasts exhibit bias, specifically a tendency to align with its inflation target. We extend the Holden and Peel (1990) test to incorporate state-dependency, defining the state of the economy based on whether realized inflation falls below the target at the time of the forecast. Our analysis reveals that the BoK's inflation forecasts are biased under this state-dependent framework. Furthermore, we examine a range of bias correction strategies based on AR(1) and mean error models, including their state-dependent variants. These strategies generally improve forecast accuracy. Among them, the AR(1)-based correction exhibits relatively stable performance, consistently reducing the root mean square error.